Oil prices sank on Monday morning after President Trump decided to reignite the trade war with China just before it was supposed to be resolved.
Trump took to twitter to announce a major escalation in the trade fight, apparently in a bid to make China buckle under the pressure. Seemingly out of nowhere, after weeks of encouraging press coverage that seemed to suggest the two sides were zeroing in on a deal, Trump said that he would hike tariffs by the end of the week, blaming China for dragging its feet.
The tweet sent global financial markets into a tailspin, not least because it caught everyone off guard. The Shanghai Composite Index fell more than 5 percent on Monday while the Stoxx Europe 600 fell by 1.5 percent. Trump says that U.S. tariffs on $200 billion of Chinese goods will jump from 10 to 25 percent by the end of this week. He also said new tariffs would go up on an additional $325 billion worth of goods. That tranche of goods, to be hit with tariffs “shortly,” would see levies at a rate of 25 percent.
The question now is how Beijing will respond. China’s vice premier Liu He was about to travel to the U.S. in what the world had widely thought would be the final sprint to a trade deal. As of Monday, a Chinese spokesman said that a trade delegation would still make the trip, although exactly who would show up was unclear.
President Trump seems to be emboldened by a series of strong jobs reports in the U.S., while China’s economy has already begun to slow.
It is unclear if Trump will follow through on the threat. In various fights over the last two years, one of his negotiating tactics is to issue over-the-top threats in an effort to browbeat his counterpart into making concessions. Often he secures a minor or even a cosmetic concession, he declares victory and scraps his threat (see: North Korea).
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It’s unclear if we will see the same script play out this time, but it is hard to imagine the U.S. following through on such a punitive measure. After all, while the U.S. economy appears to be doing well, the economies of both countries are intertwined.
“If tariffs are hiked this Friday and new tariffs come soon after that the biggest negative impact will likely occur in the next few months,” Tao Wang, an economist at UBS, said in a research note. She said that an escalation of the trade war could slash China’s GDP growth by 1.6 to 2 percentage points.
Needless to say, the damage to the Chinese economy would boomerang back to the U.S., slowing growth and presenting a series of headwinds for a variety of sectors. U.S. agriculture, for instance, has already been hit hard by the trade war, dealing American farmers their worst debt crisis since the 1980s.
The oil industry could also be dragged down by punitive tariffs. Chinese tariffs on U.S. oil and gas could rise to a reciprocal 25 percent tariff. That could scramble trade flows. “If the government adopts a tit-for-tat tariff approach and imposes additional tariffs on US crude, we may have to switch back to using West African crude,” a source with a Sinopec refinery told S&P Global Platts. At the same time, U.S. sanctions on Iran and Venezuela have curtailed alternative supplies. Chinese refiners may have to pay a premium to find supplies elsewhere. But the direct impact on oil and gas flows from tariffs pales in comparison to the broader negative impact on the global economy. Shaving a few percentage points off of Chinese GDP would erase a significant chunk of oil demand, while the knock on effects from a slowdown in China would be felt elsewhere as well. “The prospect of months of trade talks being derailed by Trump has raised concerns over future demand for oil,” Jasper Lawler, head of research at futures brokerage London Capital Group, told Reuters. It only takes a slightly lower demand figure to have an enormous effect on prices.
Yet, this scenario is not a given. As mentioned, Trump is prone to bluster, and a trade deal or a climb-down is still possible. Goldman Sachs says the possibility of a deal is only “slightly” lower after Trump’s tweet. The investment bank said the most important indicator to watch is if the Chinese trade delegation travels to Washington for negotiations, or cancels the trip altogether. If they make the trip, that suggests a deal is close. If they pull out, an agreement is “very unlikely,” Goldman said.
Oil prices recovered some lost terrain on Monday afternoon as traders continue to be concerned about the lower volumes from Iran following the full implementation of sanctions on that country.